Are weak rupee and rising oil big challenges to India's stock rally?

Analysts are concerned on the sustaining of the markets rally. Image: Shutterstock
 
Stock markets in India hit a record high on Friday, even as Brent crude climbed to the highest level in 2023 so far. The rupee, too, declined to its 10-month lowest against the US dollar in September itself. Both the factors, elevating crude prices and weakening local currency, are bad news for both the economy and equities. What explains this meteoric rise in stock markets in India despite the headwinds that could throw the rally off track?
 
Gautam Duggad, head of research, institutional equities, Motilal Oswal Financial Services, attributes the favourable blend of healthy macro and micro, moderating inflation and cooling commodity prices, global interest rates near their peak, and six consecutive months of foreign institutional investors inflows with strong retail participation led by positive sentiment as reasons for the rally in Nifty.  
 

The 50-share index hit the psychological 20,000-mark for the first time in September. After a volatile and long journey from 18000 to 19000, the Nifty added the next 1,000 points relatively faster, in only 52 trading days from July to September. This compares to 425 trading sessions from October 2021 to June 2023 during its journey from 18000 to 19000, analysis by Duggad show.
 
On Friday, the Nifty hit a high of 20,222.45 while the Sensex was also at a lifetime high of 67927.23. At the same time, oil prices climbed to the highest level of the year to settle at $93.70, after touching $93.89, its highest since November 2022. Rupee has been weakening, hovering around 83 per dollar.
 
According to Pranav Haridasan, MD & CEO, Axis Securities unlike previous times this rally is broad-based with constant sector rotation. “In the current rally, we have witnessed significant outperformance from small and mid-cap names compared to a large-cap index like Nifty,” he says.
 
Smaller stocks in both mid and smallcap segment have outperformed the index by a wide margin. Since January, the Nifty is up 11 percent, whereas the Nifty Midcap and the Nifty Smallcap are up 28 percent and 29 percent respectively.   
 
Analysts are, however, concerned on the sustaining of the markets rally. Pratik Gupta, CEO and co-head, Kotak Institutional Equities, expects markets to stay rangebound in the near term. Due to expensive valuations, he sees limited upside to the markets and limited scope for earnings upgrades and risks from a global slowdown.
 
“Conversely, Indian equities appear relatively more attractive compared to other global emerging markets which should help attract foreign flows on any declines, and local flows also remain strong given an increasing share of financial assets in household savings—which should help prevent a sharp or sustained correction. However, we remain optimistic on Indian equities over a 2 to 3-year view given the strong growth and return-on-equity (RoE) outlook,” Gupta says.
   
The rally in Indian equities is also an outcome of heavy pumping of institutional money by both domestic and foreign investors. From January, inflow of foreign institutional investors (FIIs) money was at $16.5 billion while domestic institutional investors (DII) was $14.2 billion, with $20.8 billion and $7.8 billion in March-September respectively alone.

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It is, however, unclear how lots of macro issues will play out eventually. Rishi Kohli, CIO - absolute strategies, InCred Alternative Investments, feels that higher crude prices or weaker rupee do not always have a negative correlation to markets so undue focus is given to them for medium to long-term market outlooks. “They do lead to some short-term knee-jerk reactions but it does not matter much in the long run. For example, in the 2003-2007 bull market, Indian markets rallied strongly along with crude rallying strongly,” Kohli explains.
 
However, Kohli adds that there is no denying that there are lots of macro issues that are unclear as to how they will play out finally, especially inflation that is sticking to high levels longer than many expectations. “However, markets always ride the wall of worry as they say,” he adds.
 
Typically, companies which own their revenue by selling to foreign countries and earn in dollars tend to benefit when rupee weakens. Hence, IT, metals and pharma may be clear beneficiaries of weakening rupee while mostly FMCG and chemical sectors are negatively impacted on high crude price.

Bulls versus bears: The challengers   

India is gradually entering an election phase in a challenging environment, and that may itself be a turbulent phase for stock markets rally to sustain. Duggad explains that any upside in markets from here will be a function of stability in global and local macros and continued earnings delivery versus expectations.
 
“Moreover, we note that during the last five General Elections (1999-2019), the Nifty-50 rallied 10-32 percent six months prior to the announcement of election results. India will be going into general elections in March-May 2024,” he adds.
 
The Nifty is currently at a one-year forward price-to-earnings (PE) of 18.8 times, a 7 percent discount to its own long-period average (LPA). Earnings per share (EPS) of the Nifty grew 19 percent over FY20-23 to Rs 807 versus market returns of 15 percent over January 2020-September 2023.  

Also read: The long and short of the stock market rally. How far can the bulls run?
 
“Thus, valuations are far more reasonable today than they were in October 2021 highs,” Duggad says.
 
However, Gupta agrees that the biggest challenges that India faces are global factors—such as a sharp US slowdown, unexpected interest rate increases in Japan (which has been a driver of flows into India), and higher crude oil prices.
 
“The main local factor to watch for is politics—the consensus view is that the ruling government will be re-elected next year, but we need to watch out for some key state elections at year end. However, national election outcomes have often been very different from state elections, so markets will be looking for signals confirming the assumption of political stability in India,” Gupta elaborates.
 
Besides inflation and geopolitical risks, election results will swing markets.
 
“Typically, markets get more volatile in the run-up to the elections and I do not expect anything different this time around. The election outcome will define how markets behave post the results as strong showing by ruling party versus mediocre showing vs poor showing will all lead to very different outcomes in terms of volatility as well as market direction,” Kohli adds.